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Following the lead of regulators throughout the country that have turned their attention to new financial technologies, the U.S. Federal Trade Commission recently held a FinTech Forum that focused on artificial intelligence and blockchain technologies. The agency is keen to understand the “ways in which these technologies are being used to offer consumer services, the potential benefits, and consumer protection implications as these technologies continue to develop.” We note the key take-aways from the FinTech Forum in this Client Alert.

Introduction

On March 9, 2017, the U.S. Federal Trade Commission (“FTC”) held its third FinTech Forum, which included presentations and panel discussions on the consumer protection implications of the development of artificial intelligence (“AI”) and blockchain technologies. Following the lead of regulators throughout the country that have turned their attention to these technologies, the FTC is keen to understand the “ways in which these technologies are being used to offer consumer services, the potential benefits, and consumer protection implications as these technologies continue to develop.” Reed Smith discussed the trend towards greater regulatory scrutiny of blockchain and distributed ledger technologies in a Client Alert, entitled “Regulators Prepare for Innovation in Distributed Ledger Technology,” available here.

Artificial Intelligence

Deirdre Mulligan, an Associate Professor at the UC Berkeley School of Information presented first on AI developments, discussing the capability for machines to mimic human thinking or actions, including learning and problem solving. The technology is being developed to provide, for example, personalized health care and financial services for consumers, including diagnostic and money management tools. Professor Mulligan discussed the potential for human biases to affect the programs and the potential values at risk with AI: fairness, privacy, autonomy and responsibility. She cautioned that any consumer protections should take into account whether customers understand the product, how the product works, when and if there is any handoff from computers to humans, and what biases might affect the end results. The panel discussed these items and how AI could be the plumbing of a new ecosystem but the same regulatory goals apply – disclosure and consumer protection. Ultimately, the goal is to achieve outcomes that improve lives.

Blockchain

Peter Van Valkenburgh, the Director of Research at Coin Center, presented to the FinTech Forum on blockchain technologies. He opened by comparing the concept of “the blockchain” to that of “the vehicle.” “There is no ‘the blockchain’ just as there is no ‘the vehicle,’” he explained. The first use of blockchain technology was Bitcoin. However, since then, many others have borrowed from Bitcoin’s open source code to develop novel applications that share common elements. These core elements are: (1) a peer-to-peer network; (2) a consensus mechanism; and (3) a blockchain. In other words, all blockchain and distributed ledger technologies involve “connected computers reaching an agreement over shared data.” The two elements that vary from technology to technology are the consensus mechanism and the blockchain – all such technologies involve a peer-to-peer network of connected nodes.

Mr. Van Valkenburgh raised an important issue that market participants and regulators should consider with respect to varying consensus mechanism across platforms. Lawmakers and regulators are concerned most with “permissionless,” or open, blockchains that allow anyone to join the network – such as Bitcoin and Ethereum. In recent reports issued by the Financial Industry Regulatory Association (“FINRA”), the European Securities Markets Associations (“ESMA”) and International Organization of Securities Commissions (“IOSCO”), the regulators argued that “permissioned,” or closed, blockchains that are private networks, similar to a company’s private intranet, are better-suited to survive in the heavily regulated financial services industry.

Another panel discussion on related blockchain consumer protection issues followed Mr. Van Valkenburgh’s presentation. Panelists noted that it is difficult to determine the scope of the consumer protection risks posed by blockchain technology because it is in a very early stage of development. Furthermore, there are many different types of blockchain technologies that pose varying degrees of concern for consumers. For example, smart contracts and cryptocurrencies raise different concerns for consumers than back-end clearing and settlement platforms.

The panelists agreed that education should be a priority. Lawmakers and regulators must understand how these technologies work before rushing to regulate the industry. Furthermore, regulators must reach consensus on important jurisdictional issues. For example, the U.S. Commodity Futures Trading Commission (“CFTC”) has asserted jurisdiction over the regulation of virtual currencies as “commodities” under the Commodity Exchange Act, New York State adopted the BitLicense regulations, and numerous other states have incorporated digital currency into their state money transmitter regulations in differing forms. The U.S. Securities and Exchange Commission (“SEC”) recently made a decision regarding rules affecting an exchange-traded fund (“ETF”) tied to the digital currency (our analysis is available here). Blockchain technologies have a wide variety of use cases and may spark jurisdictional battles among federal and state agencies. The panelists posited that as the technology develops, it will become clearer who is the best regulator for each space and that sandbox style monitoring is the best approach in the meantime.

The panelists also discussed the question of whether security should be at the edge of the network such that data and transactions are virtually immutable or at the center such that a central clearinghouse may alter data and transactions on the network. One of the panelists expressed concern about disintermediation in the U.S. creating large risks to consumers that outweigh any potential benefit of reduced transaction costs. In response, another panelist explained that anti-fraud and consumer protection measures can be built into platforms with security at the edge of the network using, for example, multi-sig technology, to reduce these concerns. One panelist stated that the FTC and consumers should cautiously approach blockchain, as if a “yellow caution light” lies ahead, while continuing education efforts.

Engagement with Regulators

The FTC’s consideration of the consumer protection implications of artificial intelligence and blockchain technologies demonstrates that a greater number of regulators are turning their attention to these novel technologies every day. It is important that market participants get involved in the regulatory process and voice their comments and concerns during these early stages. Market participants can, for example, submit comments to FINRA on its recent report on distributed ledger technology through March 31, 2017.

If you have any questions regarding the application of existing laws or regulations to innovative technologies or are interested in meeting with regulators or submitting comments regarding digital ledger technology to FINRA individually or in collaboration with an industry group, such as the Chamber of Digital Commerce, please contact Kari S. Larsen or Michael S. Selig.

Our FinTech Team

Our FinTech team draws on the firm’s century-long commitment to representing businesses in the financial industry, and brings that experience to bear as the industry develops in new directions. We represent emerging and mature FinTech companies in litigation and dispute resolution, as well as in transactions and counseling on a broad range of issues, including licensing, securities, regulatory compliance, risk management, IP, insurance recovery, and employment, among others.